Opus News & Insights

Review of U.S. Small Caps - January 2018Monday, February 5, 2018

Key Points

The market is off to its strongest start since 1989 as January picked up right where 2017 left off. U.S. small caps continued to march forward, returning 2.6%. This month, the market's performance was shaped by $50B in ETF flows, increased volatility, rising interest rates and a weakening U.S. dollar.For over 400 days in a row, the S&P 500 has closed within 5% of all-time highs,breaking the previous record of 394, which was set in the mid-1990s.

Last year's key themes continued to lead the market in January as large
outperformed small and growth beat value. Though a strong absolute return
to start the month, U.S. small caps' 2.6% return could not keep pace with its
larger brethren, which returned 5.7%. After a dominating performance last
year, Growth, which outperformed Value by 14.4%, continued its market
leadership, besting Value by 2.7%.

With analysts updating estimates to reflect tax-reform, growth expectations
have begun to rise, leading to decreasing valuations within small caps.
Even with this, small caps trade at a 12% premium to large caps, which is
relatively high compared to the historical average of 5%. With weaker relative
performance and strong revisions, the Russell 2000 Value Index (R2KV) now
trades at a forward P/E of 17.8x, well below the level seen in December of
18.8x. On the other hand, the Russell 2000 Growth Index (R2KG), who has
seen significant outperformance against the R2KV, saw its P/E increase from
23.5x to 23.7x since the end of the year.

The performance discrepancy between Growth and Value was driven by two
factors: increasing interest rates creating a bond-proxy sell off and increased
speculation of M&A within biotechs, driving the Health Care return. Interest
rates are rising based on better economic growth and higher inflation,
which ultimately hurt those sectors that benefit from lower rates, Utilities,
REITs, and Staples, all of which are overweights in Value compared to Growth.
Furthermore, Health Care, a significant weighting in Growth relative to Value, returned almost 10%, fueled by biotech returns.
Energy and metals & miners also proved victorious in January as the reflation trade started to gain momentum.

When interest rates rise, companies with lower leverage typically outperform, which was the case during January. With biotechs,
Energy, and metals & miners performing well this month, non-earners were the big winner. Once again, valuation factors did not
work. Dividend yield was out of favor this month and has been for quite some time. The market also favored companies with
higher short interest.

With rising rates and increased volatility, active managers performed well in January. Managers tend to benefit from higher
weights as the group is underweight bond-proxies, i.e., Utilities, REITs, and Staples, all of which, underperformed during the
month. For the month, 44.6% of small cap core managers outperformed their relative benchmarks, while Value and Growth
managers fared better with 62.4% and 64.1% outperforming, respectively. For the last twelve months, figures are slightly below
January's results as 19.4% of small cap core managers outperformed and 54.1% and 47.5% of Value and Growth managers bested
the benchmark, respectively.